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Helmut Reisen on the “China as monetary superpower” hypothesis

I have in a number of blog posts argued that China is a global or at least an Asian monetary superpower, which is exporting monetary tightening across Asia.

In a new very good blog post the former head of research at the OECD’s Development Centre Helmut Reisen discusses this hypothesis:

Usually, the current travails in emerging markets are blamed on expectations of slowing open market purchases by the US Federal Reserve System. Lars Christensen, head of emerging market research at Danske Bank, however, blames China´s monetary tightening as at least as important as the expected US Fed ´tapering´.  I have myself, with former colleagues, pointed to the growing impact that China´s growth has exerted since the last decade on GDP growth in middle- and low-income countries[1], pointing to the growing raw material, trade and production links of increasingly China centric emerging countries. So I shall have a lot of sympathy for Lars Christensen’s earlier proposition that China has also grown into a monetary superpower in a Sino monetary transmission mechanism with the rest of Asia. China´s monetary tightening, however, can hardly explain the current slump in Asian markets, on closer inspection.

So I nearly got Helmut convinced, but not quite. Here is Helmut again:

First, let us consider  the expected monetary stance in the US and in China. Graph 1 clearly shows that the market has formed expectations since May that the Fed would not continue open market purchases at the pace witnessed over the last years, partly fueled by Bernanke´s taper talk that month to US Congress. China´s monetary tightening, by contrast, occurred during late 2010 to early 2012 from when the Bank of China[2]. Since then, minimum reserve requirements were repeatedly reduced. Further, the PBC reduced its benchmark deposit and loan rates in June 2012. In addition, the PBC has also used a mix of monetary policy instruments to appropriately increase market liquidity. Even considering huge time lags, the current turmoil of Asia stock and bond markets cannot be blamed on China´s monetary tightening.

Hence, Helmut’s argument is that this is mostly caused by the Fed rather than by the People’s Bank of China. I do not disagree that the discussion of Fed tapering is having a negative impact on market sentiment in Asia. My view is just that that is not the whole story. China remains very important.

Furthermore, this is a good illustration of the Market Monetarist view of how to “measure” the monetary policy stance. While Helmut stresses that the PBoC has cut reserve requirements and interest rates recently Market Monetarists would instead focus on what markets are telling us about the monetary policy stance.

This discussion of course is similar to what happened in the euro zone and the US in 2008. Did the Fed ease or tighten monetary policy? Well, despite cutting nominal interest rates inflation expectations plummeted as did expectations for NGDP growth. That was indeed monetary tightening. And if we had good indicators for NGDP growth or inflation in China I would expect them to indicate a continued tightening of the Chinese monetary policy stance did the cut in official interest rates and reserve requirements.  The best market indicators for Chinese NGDP growth are probably copper and the Aussie dollar – and the Chinese stock market.

Hence, judging from for example the Chinese stock market monetary conditions have not become easier. Rather the opposite. And if the PBoC really had eased monetary conditions the Renminbi would have weakened significantly – it has not.

Furthermore, I would argue that communication about future changes in the money base is at least – in fact more – important than present changes to for example reserve requirements or interest rates. Hence, the communication from the Chinese authorities over the last couple of months has been decisively hawkish and if one wants to forecast the future path of the money base or the money supply in China one surely would have to conclude that the PBoC now plans a much slower rate of growth in the money supply than market participants had expected only a few months ago.

Furthermore, the PBoC’s rather clumsy handling of money market distress back in May-June left the impression that the Chinese authorities were quite happy about the impact it had on parts of the Chinese banking sector. In fact the turmoil gave reason to question that the PBoC really would act as lender-of-last-resort. That in my view was a very clear signal that the PBoC was quite happy with monetary conditions becoming tighter.

So yes, the PBoC has eased reserve requirements and cut official interest rates, but given the PBoC’s continued hawkish rhetoric market participants are not seeing the PBoC’s monetary policy stance becoming more accommodative – rather the opposite and judging from market pricing monetary contraction continues in China. That is having a clearly negative impact on the financial market sentiment across Asia.

That of course does not mean that Fed tapering is not important for what is going on in Asia at the moment. I think it is very important and it is for example clear that the sell-off in the Asian markets accelerated further this morning after the release yesterday of minutes from the latest FOMC meeting.

My point is just that the Fed is not the only monetary superpower in the world. The PBoC is also tremendously important. And on that I think Helmut and I are in total agreement.

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The Second Asian Crisis? Feeling the impact of Chinese monetary tightening

This is from Bloomberg this morning:

Asian stocks fell for a fourth day after U.S. Treasury yields reached a two-year high. Currencies from Malaysia to Thailand declined amid an emerging market exodus that’s seen investors withdraw $8.4 billion from exchange-traded funds this year.

…Indonesia’s Jakarta Composite Index dropped 3 percent, taking a four-day rout beyond 10 percent…Malaysia’s ringgit decreased for a seventh day, and the Thai baht fell 0.8 percent.

…Asian economies are struggling to ignite growth.

…Five stocks fell for every three that gained on the Asia-Pacific index. Real estate and construction firms led declines in Jakarta where the benchmark index tumbled as much as 20 percent from a high in May.

China’s economy, No. 2 in the world, has been slowing for the past two quarters. Indonesian shares led declines in emerging Asian markets yesterday, sliding 5.6 percent, after data showed the current-account deficit widened to a record last quarter. A report this month also showed the economy grew less than 6 percent for the first time since 2010 in the second quarter.

…Foreigners sold a net $3 billion of Indian stocks and bonds in July amid the slowest growth in a decade in Asia’s third-largest economy, according to data compiled by Bloomberg. The rupee slid to a record low yesterday and 30-day volatility on the CNX Nifty Index touched the highest level since April 2012.

…Thailand’s SET Index dropped 3.3 percent yesterday, the most in two months, after a report showed the economy unexpectedly shrank in the second quarter, pushing the country into a recession. The government also cut its growth forecast.

It is hard to feel optimistic about growth in Asia when you read this kind of thing.

In the article the market turmoil is blamed in Fed “tapering”, but I would suggest that Chinese monetary tightening is at least as important. Hence, China is as I have argued earlier the monetary superpower of Asia and Chinese monetary tightening weigh heavily on the Emerging Asian currencies. If the “local” central banks try to fight the currency sell-off then they are automatically importing monetary tightening from China causing growth to slump. The slump in the local stock markets is an indication that this is in fact what is partly happening.

The good news is that we are in fact seeing currencies weaken across Asia – that is softening the blow from the “China shock” . The bad news is that Asian central banks in general has been fighting the currency sell-off by hiking interest rates, intervening in the FX markets and by introducing all kinds of draconian currency controls. All that is likely hit growth across the region. And yes, I am quite nervous about new cases of monetary policy failure, where local policy makers in their attempts to curb the currency sell-off end up doing more bad than good. Just take a look at stop-go policies of Bank Indonesia and the Reserve Bank of India over the past two months.

The best way to shield the Asian economies from the negative impact of Chinese monetary tightening and fed tapering is to let currencies float completely freely and to the extent necessary letting the currencies weakening. Trying to fight the currency sell-off with monetary tightening is the recipe for setting of the Second Asian Crisis. As long as the impact of the Chinese monetary tightening continues Asian policy makers have the choice between weaker currencies or lower growth.  You cannot have both in the present situation.

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